Municipal bonds bounce back

May 17, 2011: 4:57 PM ET

NEW YORK (CNNMoney) -- The municipal bond market has been showing some signs of life, with yield-hungry investors showing an appetite for state and local government debt.

Yields on AAA municipal bonds have fallen for 25 consecutive trading days, as prices have risen, according to Thomson Reuters Municipal Market Data. The yield on a benchmark 10-year AAA muni bond tracked by the group fell on Tuesday to 2.59%, the lowest level since late November.

The renewed interest in munis comes after investors pulled billions of dollars out of the market amid fears that cash-strapped states and local governments would default on their debts.

About $30 billion flowed out of the municipal bond market between last December and the end of March, according to the Investment Company Institute.

While many states continue to struggle with massive deficits, some investors say worries about a wave of defaults are overblown. And the recent selloff has made many muni bonds relatively cheap, analysts said.

Investors have also been taking a second look at munis as an alternative to U.S. Treasury bonds, said Kim Rupert, a fixed-income analyst at Action Economics.

"With Treasury yields so low, people are looking for a little something extra," she said. Because they are considered more risky, muni yields are usually richer than Treasury yields, she added.

But thanks to the recent run into munis, that's no longer the case. The yield on the benchmark 10-year Treasury bond fell to 3.21% on Tuesday, down from around 3.7% in early February.

Muni bonds are tax free though, so that's another added bonus for investors when compared to Treasury bonds.

Analysts say the muni market could come under pressure in the weeks ahead as state and local governments increase supply.

But the recent interest in munis suggests that the market will be able to digest the new issues, according to Alan Schankel, a fixed income analyst at Janney Capital Markets.

"Demand has been robust and may be increasing as we enter the strong summer reinvestment period," he said, adding that an estimated $50 billion in muni bonds will mature or be redeemed in June. "The demand side of the scale will outweigh supply in coming weeks." To top of page

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